Taking Stock of Chapter 11

Abstract

In this Essay, written for a symposium honoring Sam Gerdano, I offer an assessment of current Chapter 11 theory and practice. The most distinctive feature of current Chapter 11 practice is the extent to which the parties now enter into intercreditor agreements, restructuring support agreements and other actual contracts governing their rights and responsibilities. One question raised by the dramatic shift in bankruptcy practice is whether the leading normative theory of bankruptcy, the Creditors’ Bargain Theory, is now obsolete, as some scholars have suggested. The Creditors’ Bargain Theory explains bankruptcy as a solution to coordination problems that might lead to the dismemberment of an otherwise viable firm if creditors were simply left to their own devices. Although the particular coordination problem foregrounded by the theory—the collective action problem faced by widely scattered unsecured creditors—no longer characterizes most Chapter 11 cases, I argue that this bargaining failure has been replaced by others to which the same logic applies.

The theory provides a much more complete picture of why bankruptcy is necessary than of the optimal framework for resolving financial distress. In current practice, the key question is how to make sense of the contracts that now govern the Chapter 11 process. Building on earlier work with George Triantis, I argue that the principal objective should be to distinguish between ex ante and ex post agreements, and to balance the costs and benefits of each. I consider the implications of this perspective for debtor-in-possession financing and managerial bonuses.

Keywords: Bankruptcy law & practice, legal theory, reorganization, creditors’ bargain, contract paradigm, ex post & ex ante contracting, intercreditor & restructuring support agreements, debtor-in-possession, judges, Samuel J. Gerdano, American Bankruptcy Institute

JEL Classification: G33, K22